Wednesday, August 1, 2012

The first estimate of the 2nd quarter real Gross Domestic Product (GDP) came in Friday morning at an extremely sluggish 1.5% annual rate.  The report, however, coupled with European Central Bank (ECB) President Mario Draghi’s announcement on Thursday that the ECB was “prepared to do whatever it takes” within the ECB’s mandate, propelled the Dow Jones Industrial Average (DJIA) to its highest close since May 4th.

The DJIA added 400 points Thursday and Friday combined pushing the DJIA to a 253-point gain for the week (+2.0%).  The increase marked the fourth best weekly return for the Dow out of 30 trading weeks so far in 2012 and pushed the DJIA to a yearly gain of 7.0%.  The other major US indexes were all positive with the S&P 500 adding 1.7%, the Russell 2000 increasing 0.6%, and the NASDAQ rising 1.1%.  For the year, the S&P 500 is up 10.2%, the Russell 2000 is up 7.4%, and the NASDAQ is up 13.6%.

All but one of the major eleven economic sectors was positive last week.  Telecom, Industrials, and Financials led among sectors and beat the DJIA’s weekly gain.  Materials, Real Estate, and Utilities were the bottom three performing sectors with only Materials negative for the week.  For the year, Real Estate, Health Care, and Consumer Discretionary lead all sectors as well as outperforming the NASDAQ, the best performing major stock index in 2012.  Several other interesting observations are worth noting as July draws to an end.  First, every sector is positive for the year.  For much of the past four or five months at least one sector (either Energy or Utilities) was negative, but with the positive market action last week, this is no longer true.  Second, the spread between the best performing and worst performing sectors is relatively small (less than 14%).  I realize that there are 22 trading weeks left in the year, but at this point, I can say that this spread is about half of the lowest spread years (2010 and 2006) and significantly less than the roughly 39% yearly spread since 2003.

Europe rallied last week on the ECB president’s remarks, but as has been the case most of the year, continued to lag the US.  The MSCI (EAFE) index gained 1.2% for the week and is now up 1.0% for the year.  Looking back one year, most international country indexes are down with Europe and Asia hardest hit.    

The Euro gained nearly two cents (1.4%) to close Friday at $1.232 posting its first positive week in the past four.  In addition to Mr. Draghi’s comments, both German Chancellor Merkel and French President Hollande announced their firm support for the Euro on Friday.  The three announcements clearly moved the markets in a positive manner, but it remains to be seen if any of the three can deliver on a long-term solution for their region.

Europe’s immediate problem emerged last week from the bond markets.  Even with the pledge of a direct 100 million ($1.2 million) bailout for Spanish banks, the 10-year yield on Spanish government debt surged beyond 7.5% mid-week.  I have little doubt that it became clear to Mr. Draghi at the ECB that Spain was going to lose access to the private debt market making it impossible for Spain to service its growing debt.  This would pose severe problems for Spain and the entire European Union (EU).  This realization led to Mr. Draghi’s comments on Thursday and the German and French leaders’ supportive comments on Friday.  This verbal action had an immediate effect on bond markets pushing Spain’s rate down to 6.74%--high, but manageable for now.  US Treasury yields jumped as investor demand for the “safe-haven” US Treasuries diminished.  The 10-year yield finished Friday at 1.544% up from the previous week’s close at 1.459%.  The Barclays Aggregate Bond Index fell -0.3% for the week resulting in the first negative week of the past five.  For the year this broad US bond index is up 3.6%.  High Yield and Short-term International bonds were the best performing bond sectors last week while long-duration US Treasuries were the worst.

Commodities were a mixed bag last week.  The broad Dow Jones UBS Commodities Index fell by 1.9% last week led by weakness in coffee, sugar, natural gas, and agriculture.  The drought in the US continues to have an impact on future corn and livestock prices, but that increase has not been fully realized or found its way into the food supply chain—yet.  Gold jumped $40.00 (2.5%) last week to close Friday at $1622.70, the highest Friday close since June 1st.  This move is at least partly explained by the ECB and the US Federal Reserve giving signals that they may engage in another round of quantitative easing (QE).  QE puts pressure on currencies and gold is the hedge against weakening currencies.  As I have said in the past, watch the price of gold to assess the strength of paper currencies and likelihood of further weakening of those currencies.  Oil has been trending upwards after falling the past month or two.  I believe a weaker US dollar and concerns about unrest in the Middle East helped push prices higher.  A barrel of WTI Oil closed Friday at $90.13 down 1.6% from the previous Friday close of $91.56.  This small drop follows two weeks where the price of oil gained $7.11 per barrel (+8.2%).


To say that there are headwinds, dark clouds on the horizon, or a blizzard of bad news about the economy is to admit that I have used a couple too many weather metaphors to describe what is without a doubt, a bad world economy.  The US GDP output shrank to a lousy 1.5%, Spain is on the verge of losing access to the capital markets, Greece may force private bondholders to take another 30 billion haircut to keep that country on its debt target, and unemployment is high and staying high.  So why has the market rallied in the face of such bad news?

The answer may be as simple as two words—low expectations.

Going into Friday’s GDP report, the Wall Street Journal reported that the consensus for the 2nd quarter GDP growth rate was 1.2%, so when the rate came in at 1.5%, this news was actually better than expected and markets rallied.  This rally in the markets does not mean that the economy is suddenly going to do better, it means that investors had adjusted the valuation of stocks downward in anticipation of a 1.2% growth rate.  In hindsight, it turns out that investors over-corrected and stocks rallied to meet current growth expectations.  Additionally, because the report was so bad, the expectation that the Federal Reserve may start pumping more cash into the economy was increased helping push up stocks.

I would like to make a couple of other key points regarding the past few months.  First, headline news can be tough to deal with.  There is a lot of bad news out there.  The 24-hour news cycle means that all of us are bombarded with news around the clock.  I remember as a kid in the early to mid-‘70’s that you got your news in brief chunks each day.  The morning paper, 30 minutes of local news and 30 minutes of national news at dinnertime, and another 30 minutes of local news late night.  There was a lot of bad news out there, but it was not a constant drumbeat and it was easy to get away from the noise and focus on other things.  Maybe that was not the right answer either, but you cannot let all this negative economic news lead to poor investment decision making.

This leads me to my next point…having sound technical analysis to assist in basic investment decision making is invaluable.  As my regular readers know, the New York Stock Exchange Bullish Percent (NYSEBP), after falling 12 straight weeks from March 19th thru June 8th, this key barometer of market momentum began to rise.  Stock indexes did not turn immediately, but they did bottom just prior and have slowly made their way back with the DJIA adding some 1000 points.  It has been anything but a straight line, but by knowing that demand for stocks (NYSEBP rising) has made it easier to stay committed to stocks in the face of unrelenting bad economic news.

The US and global economies have tremendous challenges ahead of them.  The interplay between central banks, politicians, countries, government created organizations (like the International Monetary Fund), companies, and people is very complex and extraordinarily difficult to predict.  That is why I do not predict.  I look for trends and point them out when I see them occurring.  The research I receive from Dorsey Wright & Associates is central to my technical analysis, and I share my views based upon their research with you each week.

The efforts taken or will be taken by central bankers can only protect countries (and markets) for just so long.  Political leaders must correctly identify the problems they are confronted with, implement appropriate policies, and explain to their constituents why they are taking such actions, is the only chance I believe for long-term economic success.  Otherwise, we may be faced with extended periods of very slow growth, high unemployment, and consumer malaise. 

As long as the signals tell me that it makes sense to be engaged in the stock market, I will do my best to tell you where the opportunities are.  When the signals tell me to be somewhere else, you can be assured I will share my observations with you then as well.  It is tough for sure, but as we have seen by a 1.5% GDP growth for the quarter, Americans are tough in general and will do everything they can to grow their wealth and productivity.


There are a series of important economic reports due out this coming week.  Personal Income and Outlays will be released Tuesday morning.  This report is always important because it gives insight into how much Americans are making and whether or not they are spending.  Wages have been essentially stagnate for some time now and may help explain why consumer spending is not picking up.  Personal income is expected in increase by 0.4% and spending is expected to increase by 0.1%.  The July ISM Manufacturing Index will come out Wednesday and is expected to show a slight increase in manufacturing activity over June’s report.  Thursday will have the weekly Initial Jobless Claims report (370,000) and Friday has July’s Unemployment Report.  This very important report is expected to show that jobs increased by 100,000 in July, but that the overall unemployment report will remain at 8.2%.
The Federal Reserve is meeting this week and will announce at 2:15 PM Wednesday their decision on interest rates—there is little chance that the Fed will make any change.  More importantly, investors will be looking for some signs from the Fed Chairman, Ben Bernanke, about the Fed’s intention to take action to stimulate the economy further.  This has very important implications for all markets, not just the stock market, because the introduction of fresh cash into the economy can have positive short-term effects
The Dorsey Wright & Associates (DWA) current technical analysis shows US stocks and Bonds as the two strongest major asset classes followed by Currencies, International stocks, and Commodities.  Within the US stock asset class, Middle capitalization stocks are favored, growth is favored over value, and equal-weighted indexes are favored over capitalization-weighted indexes.  On a relative strength basis, Real Estate, Consumer Discretionary, and Health Care are the strongest major economic sectors.  Energy, Telecom, and Materials are the weakest.  Within the Bond asset category, US Treasuries and International bonds are favored. 
The New York Stock Exchange Bullish Percent (NYSEBP) closed at 53.32 falling from 54.21 the previous week.  This is the first drop in seven weeks and I will watch closely to see if this move is marking a peak in this current move of the NYSEBP or just a brief pause.  Municipal bonds remain very overbought indicating that prices have gotten very expensive in relation to prices over the past ten weeks.  I would not initiate new positions here. 


Paul L. Merritt, MBA, AIF®, CRPC®
NTrust Wealth Management

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Past performance is not indicative of future results and there is no assurance that any forecasts mentioned in this report will be obtained.  Technical analysis is just one form of analysis.  You may also want to consider quantitative and fundamental analysis before making any investment decisions.

Information in this update has been obtained from and is based upon sources that NTrust Wealth Management (NTWM) believes to be reliable; however, NTWM does not guarantee its accuracy. All opinions and estimates constitute NTWM's judgment as of the date the update was created and are subject to change without notice. This update is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of a security. Any decision to purchase securities must take into account existing public information on such security or any registered prospectus.
Emerging market investments involve higher risks than investments from developed countries and involve increased risks due to differences in accounting methods, foreign taxation, political instability, and currency fluctuation. The main risks of international investing are currency fluctuations, differences in accounting methods, foreign taxation, economic, political or financial instability, and lack of timely or reliable information or unfavorable political or legal developments.
The commodities industries can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions. Past performance is no guarantee of future results. These investments may not be suitable for all investors, and there is no guarantee that any investment will be able to sell for a profit in the future.  The Dow Jones UBS Commodities Index is composed of futures contracts on physical commodities.  This index aims to provide a broadly diversified representation of commodity markets as an asset class.  The index represents 19 commodities, which are weighted to account for economic significance and market liquidity.  This index cannot be traded directly.
TIPS are U.S. government securities designed to protect investors and the future value of their fixed-income investments from the adverse effects of inflation. Using the Consumer Price Index (CPI) as a guide, the value of the bond's principal is adjusted upward to keep pace with inflation. Increase in real interest rates can cause the price of inflation-protected debt securities to decrease.  Interest payments on inflation-protected debt securities can be unpredictable.
The NYCE US Dollar Index is a measure that calculates the value of the US dollar through a basket of six currencies, the Euro, the Japanese Yen, the British Pound, the Canadian Dollar, the Swedish Krona, and the Swiss franc.  The Euro is the predominant currency making up about 57% of the basket.

Currencies and futures generally are volatile and are not suitable for all investors.  Investment in foreign exchange related products is subject to many factors that contribute to or increase volatility, such as national debt levels and trade deficits, changes in domestic and foreign interest rates, and investors’ expectations concerning interest rates, currency exchange rates and global or regional political, economic or financial events and situations.

Corporate bonds contain elements of both interest rate risk and credit risk. Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest, and if held to maturity, offer a fixed rate of return and fixed principal value. U.S. Treasury bills do not eliminate market risk. The purchase of bonds is subject to availability and market conditions. There is an inverse relationship between the price of bonds and the yield: when price goes up, yield goes down, and vice versa. Market risk is a consideration if sold or redeemed prior to maturity. Some bonds have call features that may affect income. 

 The bullish percent indicator (BPI) is a market breath indicator.  The indicator is calculated by taking the total number of issues in an index or industry that are generating point and figure buy signals and dividing it by the total number of stocks in that group.  The basic rule for using the bullish percent index is that when the BPI is above 70%, the market is overbought, and conversely when the indicator is below 30%, the market is oversold.  The most popular BPI is the NYSE Bullish Percent Index, which is the tool of choice for famed point and figure analyst, Thomas Dorsey.

All indices are unmanaged and are not available for direct investment by the public.  Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poors and is a capitalization-weighted index meaning the larger companies have a larger weighting of the index.  The S&P 500 Equal Weighted Index is determined by giving each company in the index an equal weighting to each of the 500 companies that comprise the index.  The Dow Jones Industrial Average is based on the average performance of 30 large U.S. companies monitored by Dow Jones & Company.   The Russell 2000 Index Is comprised of the 2000 smallest companies of the Russell 3000 Index, which is comprised of the 3000 biggest companies in the US.   The NASDAQ Composite Index (NASDAQ) is an index representing the securities traded on the NASDAQ stock market and is comprised of over 3000 issues.  It has a heavy bias towards technology and growth stocks.